Essays in financial economics

Abstract

This thesis contributes to the literatures on socially responsible investment and banking regulation. In the first paper, I ask how socially responsible investors (SRI) should allocate their capital to influence firm behaviour in the framework of a vertical production economy. This simple production network opens up the additional question of whether supply-chain policies should be imposed. The optimal strategy depends on the amount of funds available to the SRI, relative to the value of the economy. When SRI wealth is low, it is optimal to target the sector with the lowest effective reduction costs, and to refrain from supply-chain policies. However, when SRI wealth is sufficiently high, it becomes optimal to target downstream firms and prescribe a “green” supply chain policy. This result arises because supply chain policies incentivize upstream firm owners to turn green, but only if a critical mass of downstream firms imposes such requirements. The second paper analyzes the effects of tightened bank capital requiremens on lending in a dynamic setting. It is motivated by empirical observations of temporary rather than long run lending declines and sluggish increases of equity levels. I provide an overview over the set of distinct mechanisms that may rationalize this finding by driving a wedge between the costs of external and internal equity. The considered demand-side frictions are direct issuance costs, adverse selection, debt overhang and control dilution reluctance, while I also discuss the potential role of inelastic short-run equity supply. While the theoretical merits of and empirical evidence on these mechanisms’ core premises tend to be strong for the banking sector, empirical results about their effects on equity issuances and interactions with capital regulation are more mixed and scarce. I discuss interactions between these frictions and policy recommendations that depend not only on their joint significance but also on the contribution of the single components of these “flow costs of equity”.